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No part of this pub­ lication may be used or reproduced in any manner whatsoever without permission in writing from the American Enterprise Institute except in the case of brief quotations embodied in news articles, critical articles, or reviews. The views expressed in the publications of the American Enterprise Institute are those of the authors and do not necessarily reflect the views of the staff, advisory panels, officers, or trustees of AEI. "American Enterprise Institute" and @)are registered service marks of the American Enterprise Institute for Public Policy Research. Printed in the United States of America Preface Since the American Enterprise Institute initiated its "Conversations" in 1975, a number of outstanding public figures, scholars, and spe­ cialists have contributed to the formation of public policy through them. Among many others, AEI has invited Senator Richard Lugar, Senator Daniel Patrick Moynihan, Lane Kirkland of the AFL-CIO, Secretary of Labor Ray Marshall, Robert Strauss, Gerald Ford, George Bush, the Reverend Jesse Jackson, Vladimir Bukovsky, John Con­ nally, and Mayor Marion Barry of Washington, D.C. The format for these conversations-a brief presentation, fol­ lowed by discussion with members of a limited audience of AEI scholars and guests-is intended to produce a minimum of "talking at" the audience and a maximum of speaking to, and listening to, each other. The transcript of the discussion has been edited as lightly as possible to preserve its informal conversational tone. We believe that this sort of exchange offers a perspective on the thinking of important public figures very different from that found in their prepared speeches and published writings. And, we believe, it is an excellent way to encourage the "competition of ideas" that is AEI' s trademark. WILLIAM J. BAROODY, JR. President American Enterprise Institute for Public Policy Research Introduction The Honorable Alfred Kahn, advisor to the president on inflation, has had a long and distinguished career in academia and in public service.He was educated at New York and Yale universities and has taught at Ripon College and Cornell University. He is a prolific writer, and his works include a widely acclaimed two-volume set on regulation.* Dr. Kahn has had extensive public service as chairman of the New York State Public Service Commission (1974-1977), chair­ man of the U.S. Civil Aeronautics Board (1977-1978), and chairman of the U.S. Council on Wage and Price Stability and advisor to the president since October 24, 1978.In addition, Dr.Kahn is a member of the Research Advisory Committee to AEI's Center for the Study of Government Regulation and has participated in several AEI pro­ grams. Inflation is perceived to be the nation's number one domestic problem. As Dr. Arthur Burns recently testified before the Senate, "Inflation ... acts like a giant lottery, with the distribution of out­ comes both arbitrary and perverse; prudence is penalized, improv­ idence rewarded." Dr.Kahn has grappled with this enormous prob­ lem for well over a year and has steered clear of the temptation to call for wage and price controls. Through it all, Dr. Kahn has maintained good humor, despite public rumblings about an ever increasing inflation rate. Undoubt­ edly, Dr. Kahn has also experienced substantial opportunity costs. In a recent Fortune magazine article by Steven Solomon, Harry Walker, the highly successful agent for prominent speakers, is quoted as viewing Kahn as one of his favorite prospects. "With *Alfred E. Kahn, The Economics of Regulation: Principles and Institutions, 2 vols. (New York: John Wiley & Sons, Inc., 1970). 1 Kahn, I could support my five grandchildren in Israel," he says. One suspects that when Dr. Kahn does finally choose to leave gov­ ernment service-and perhaps go on the lecture circuit-he will surely be missed. JAMES C. MILLER Ill American Enterprise Institute 2 A Conversation with Alfred E. Kahn DR. KAHN: Instead of the talk that I have been giving for the last week or so on the president's new anti-inflation program, I am terribly tempted to begin with the talk I gave yesterday, on the subject of speaking and writing plain English. It's not only much more fun; it is also much easier for me to know what's right and what's wrong in that area. One of the consolations of my present situation, however, is that the life expectancy for inflation czars is mercifully short-a sit­ uation that reminds me of the late Arthur Okun's reference to P.T. Barnum's prescription for keeping a lion and a lamb in the same cage: keep a plentiful reserve supply of lambs. The same rule, I fancy, applies to inflation czars. This audience is as aware as I am of the major outlines of the intensified anti-inflation program that the president announced re­ cently, and of the circumstances that elicited it. I refer to the accel­ eration not just of the producer price index (PPI) and consumer price index (CPI), but, more ominously, of the underlying rate that much more accurately reflects the dimensions of the longer-term inflation problem, free of the transient influence of short-term shocks. The acceleration of the CPI and PPI during the last fifteen months, and again within the last three months, was in very large measure a phenomenon of high energy prices and mortgage interest rates, both of which are bound in some degree to be proved temporary. Much more worrisome is the behavior of what is left in the CPI after one removes energy, mortgage interest rates, and food-the latter, similarly, in consideration of the fact that the price of food at the farm is subject to wide short-term fluctuations. That residual rate had been running quite steadily at about 7V2 percent in the first half 3 of 1979, and 8 to 8% percent in the latter part of the year. In the first quarter of 1980, however, it jumped to 12 percent. Similarly, wage increases, which had for most of 1979 run actually below the 1978 level, also began to speed up toward the end of last year and the beginning of this one; and with productivity behaving as badly as it has, this too has meant an acceleration in the rate of increase in our fundamental cost structure. In addition, we witnessed in the first months of this year a virtual collapse of the bond market, which was in part a consequence of the disclosure that the federal budget for fiscal 1980 was going to produce not the $29 billion deficit that had been predicted only a short time before, but one in the low forties. As I say, I am sure that most of this audience is familiar with the main components of the program that President Carter felt im­ pelled to introduce. The first was his promise of a balanced budget for fiscal 1981. The fate of that rather rash prediction will depend, of course, on what happens to the economy generally. But the re­ ductions in federal expenditures, on the order of $15 billion, that he has requested are real, and, I assure you, painful. I trust you will not be misled by the logic of the Wall Street Journal, which deprecated the cuts by pointing out that the revised budget estimate that the president presented at the same time showed fiscal 1981 expendi­ tures going up by $9 billion; the $13 billion of cuts that it foresaw, it triumphantly observed, would therefore mean a net decline of only $4 billion.